1. (SBU) The IMF recently concluded its annual Article IV visit to
Egypt, issuing a preliminary report lauding the success of Egypt's
macroeconomic reform. The report cited strong economic growth and a
decline in unemployment as signs of the program's success.
Inflation is a concern, but the spike in early 2007 was due to
one-off events, not underlying inflationary pressure. More reform
is needed to attract more investment, if Egypt's economy is to grow
at a rate sufficient to sustain job creation. The deficit must also
be reduced, and the GOE has an ambitious plan to reach a deficit of
3% by FY10/11. Cyrus Sassanpour, IMF Resident Representative,
agreed with the Treasury Attache that the report was quite positive,
and noted that the GOE could reach its deficit reduction target
simply by consistently cutting fuel subsidies. Sassanpour
recognized the need for continued reform, and believes now is the
time - when the economy is performing well - to enact those reforms.
While the report accurately reflects improved macroeconomic
figures, it does not mention some of major problems still facing
Egypt's economy, including corruption.

2. (U) The IMF's preliminary Article IV report, issued September
12, lauded Egypt's macroeconomic reform, highlighting estimated real
GDP growth of 7.1% in FY06/07 (July 2006 - June 2007) and a decline
in unemployment from 10.5 to 9% as evidence of the program's
success. Strong growth was supported by record FDI inflows, (the
GOE estimates FDI will reach $6 billion in FY06/07), which also
fueled inflation as domestic demand increased. Peaking at 12.8% in
March 2007, inflation has since decreased to 8%. The IMF report
echoed official GOE assertions that the spike in inflation was
caused by an avian flu outbreak and fuel subsidy reductions, and is
therefore not a long-term concern. The report predicts inflation
will average 6-8% for the next few years - consistent with an
economy growing at 6-7% annually, with annual FDI in the range of $6
billion - provided money growth does not increase more than 15%.

3. (U) The fiscal deficit declined from around 9% in recent years
to 7.5% in FY06/07, due to structural reform of the tax system,
subsidy reductions, a Treasury Single Account, and windfall profits
from issuance of a third mobile phone license. Privatization
proceeds also increased revenues, and spurred private sector growth.
The July 2007 issuance of Egypt's first international local
currency bond will help establish a benchmark interest rate and aid
in domestic capital market development, according to the report
(Note: The bond has an unusual design: Denominated in dollars,
proceeds from the issuance were given to CBE to convert into Pounds
at the existing exchange rate. At interest payment times and at
maturity, the Ministry of Finance will calculate and pay interest to
CBE in Pounds, which will convert the Pounds back into dollars at
the existing exchange rate before pay out to investors. Under this
design, investors take the exchange rate risk, not CBE).

----------------------
More Investment Needed
----------------------

4. (U) The IMF noted that to sustain growth and job creation,
investment equal to 26% of GDP is needed over the next few years.
Obstacles to this level of investment include poor infrastructure
and government services, lack of credit to SMEs, and lack of trained
labor. Further structural reforms are also needed to meet the GOE's
deficit target of 3% by FY10/11. While expressing confidence in the
GOE's ability to meet this target, the report notes that deficit
reduction is the overarching challenge for the GOE (Note: Several
of the IMF recommendations for reducing the deficit, including
property and sales tax reform and improved cash management, are
benchmarks under the "Private Sector Development" portion of the
proposed new USAID cash transfer program). The IMF also recommends
that fuel subsidies - currently 5-6% of GDP - be further reduced.
Such reduction would discourage investment in energy-intensive
industries in which Egypt does not have a long-term comparative
advantage, according to the report.

5. (U) While noting the potential for "reform fatigue" as some are
adversely affected and/or disappointed with reform, the IMF
encourages Egypt to take advantage of the favorable outlook to

continue with reform. The report was broadly supportive of CBE's
movement toward an inflation-targeting monetary policy, and
encouraged more privatization in the banking sector, which is
already approximately one half private sector-owned resulting from a
financial sector reform program. The full Article IV report is
expected to be considered by the IMF Board in November.

6. (SBU) Cyrus Sassanpour, IMF Resident Representative (ResRep)
echoed the report's laudatory assessment to TreasAtt. While
praising the solid macroeconomic numbers, he recognized that the GOE
data, upon which the report is based, is not always reliable. Local
analysts, including Sassanpour, believe that the GOE consistently
underestimates unemployment. Sassanpour was especially critical of
the Central Agency for Public Mobilization and Statistics (CAPMAS),
the main data gathering agency, though their information has
improved somewhat in recent months. Budget transparency has
improved, according to Sassanpour, largely due to the Minister of
Finance's efforts to increase transparency in GOE agencies. Despite
improved budget transparency, and improvement in the way fuel
subsidies are shown in the budget, the Article IV report cited
transparency in the Egyptian General Petroleum Company as an area
still in need of improvement (Comment: Improved budget transparency
is one means of empowering civil society to demand greater
government accountability. We are hopeful that increased USG and
donor attention to this issue will have some democracy dividends).

7. (SBU) Sassanpour also noted that the dividends of macro reform
are being felt, as investors now see Egypt as a stable investment
destination, a view backed by the growing FDI figures. He argued
that the GOE can meet its target of reducing the fiscal deficit by
1% of GDP annually simply by consistently cutting subsidies. The
GOE has put forth a plan to reduce energy subsidies to industry over
the next five years, and Sassanpour expects another cut before the
end of the year. On the revenue side, better enforcement of the new
tax law is needed, but the new law itself, coupled with
restructuring of the Tax Authority, is a major achievement. Within
the MENA region, Sassanpour argued that Egypt is now a tax reform
leader, a view expressed by other MENA countries at the last
OECD-MENA Investment Conference.

8. (SBU) While the macro picture continues to be fairly rosy,
Sassanpour noted that more reform is still needed in the real
economy, particularly in agriculture, infrastructure, labor markets,
and skills training. These reforms need to happen while the economy
is doing well, so the difficult adjustments required by such reforms
can be offset by overall growth and job creation.

-------
Comment
-------

9. (SBU) While the IMF report accurately reflects the improved
macroeconomic environment in Egypt, the macroeconomic picture is
only part of the overall economic landscape. The Minister of
Finance, with whom the IMF works closely, has made monumental
efforts to improve Egypt's fiscal situation. His efforts, however,
and those of economic reformers in general, continue to face
political obstacles and sectoral challenges. Corruption remains a
major impediment to growth. The culture of cronyism and family
connections is still deeply rooted in Egyptian society, and affects
the business sector from start up through operation and expansion.
Business owners still need the right "connections" to facilitate
access to land and utilities, issuance of licenses, financing, and
contracts. The World Bank, which works more closely with the
financial sector than does the IMF, has a decidedly more skeptical
view of the likelihood of continued economic reform (septel).

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